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What Will Happen to Interest Rates?

A critical ingredient for enlivening the commercial real estate market is the availability of credit at terms that are attractive to borrowers. Interest rates have been low, but credit has been hard to come by due to the two-year turmoil in the financial markets and the lingering effects of the recession. If mortgage interest rates remain low, they can facilitate a recovery in the commercial real estate market, and more broadly throughout the economy. What is likely to happen in the credit markets in 2010 and beyond?

Long-term mortgage rates are likely to rise due to government deficit spending, as the Federal govern­ment will have to offer higher interest rates to creditors to continue attracting capital. As shown in the accom­panying graphs, the U.S. Treasury supply is increasing dramatically during the 2009-1 1 period to accommo­date the deficit spending that is intended to spur an economic recovery.

At the same time, some buyers of debt, such as China, are easing back on their purchases of American trea­suries for both financial and political reasons, which will drive the U.S. government to increase interest rates in order to make U.S. treasuries more attractive to foreign buyers. As interest rates for U.S. treasuries rise, mortgage rates for commercial properties will follow suit.

We believe that the availability of credit will increase in 2010, but that interest rates will increase 100 to 300 basis points in the next

12 to 36 months. While availability of debt will

remain a problem during 2010, despite some improvement, real estate investors who have access to

credit should be prepared to act quickly this year

before rates become less attractive.

With an increase in mortgage interest rates, we expect three significant effects for the commercial real estate market:

1. Cap rates that began to settle down at the end of 20091ikely will not decline much in 2010-11 even if good product is in short supply (as some brokers suggest).

2. Cash will remain king for at least another year.

3. It is possible that development lending

will remain lean over the next 12-24

months, leading to a "hole in the

market" for deliveries of new product,

and creating rent spikes in 2012-15.

If you are an investor in commercial real estate with cash or access to credit, consider deploying your resources soon, while prices and interest rates are low. While values may continue to edge down, the cost of leverage is likely to rise substantially in the near future, hampering returns.
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